With an army of shareholders, the Rolls-Royce (LSE: RR) share price is a matter of great interest for many people. After aviation demand fell sharply last year, the aerospace engineer has faced very challenging market conditions. Some investors think a recovery in demand will help boost the group’s fortunes and boost the share price. Here’s my take.
Travel demand will come back
A lot of the company’s revenue comes from selling and servicing engines. Aviation regulations mean that engines need certain levels of service for every number of hours they spend flying. So, an aviation downturn hurts companies like Rolls-Royce not just because the order book for new engine sales can get thinner. A fall off in travel also leads to lower demand from aircraft operators for servicing.
I take the view that travel demand will come back after the pandemic. Sooner or later, people will want to fly for leisure again and business travel will return in some form. What is not obvious is how fast that recovery will be. That will affect the Rolls-Royce share price.
That is important when considering the investment case for Rolls-Royce. It has been ruthless in cutting costs, reducing 7,000 jobs last year. Nonetheless, an engineering company has high fixed costs and needs to invest in research and development for future growth. The longer it takes for air travel demand to recover, the longer it will be before business gets back to normal.
Currently, the aerospace specialist is burning cash. It expects cash burn of around £2bn this year, on top of a larger number last year. That is so even though it expects to turn cash flow positive in the second half of the year. The company’s engines are built to withstand strong headwinds – and so are its finances. It has around £9bn of liquidity after raising cash last year. If it needed to, I expect it could raise more. Nonetheless, the sooner travel demand recovers, the sooner I would expect the Rolls-Royce share price to do the same.
The Rolls-Royce share price is sensitive to bad news
The company has changed its forecast of likely aircraft utilisation this year. It still forecasts a figure for larger planes of around 55%, and 90% for next year. If those figures eventuate and the company hits its target of turning cash flow positive this year, I expect investor sentiment towards the shares could improve. That could push the shares towards 150p.
However, for now it is unclear whether air travel will indeed return at that rate and on those timings. After all, many countries have not yet begun their vaccination programmes. Additionally, behavioural shifts such as the use of online meetings for some types of business may have led to structural shifts in demand for air travel.
The Rolls-Royce share price has continued to disappoint. Not only has there been the massive loss during the pandemic, but last year the shares were also heavily diluted as part of the company’s efforts to improve liquidity. More bad news, like a slower-than-expected return of air traffic, could further hurt the shares. Whether they hit 150p relies on a big unknown, in my view. I like investing in companies with clearer routes to sustained profitability. That’s why I am not selecting Rolls-Royce for my portfolio.
